Notes of CFA Level1 READING 38: PORTFOLIO MANAGEMENT: AN OVERVIEW

 modern portfolio theory (MPT). MPT results in equilibrium expected returns for securities and portfolios that are a linear function of each security’s or portfolio’s market risk (the risk that cannot be reduced by diversification).

diversification ratio

If the average standard deviation of returns for the n stocks is 25%, and the standard deviation of returns for an equally weighted portfolio of the n stocks is 18%, the diversification ratio is 18 / 25 = 0.72. 

Computer optimization can calculate the portfolio weights that will produce the lowest portfolio risk (standard deviation of returns) for a given group of securities. 

An endowment is a fund that is dedicated to providing financial support on an ongoing basis for a specific purpose. For example, in the United States, many universities have large endowment funds to support their programs.

A foundation is a fund established for charitable purposes to support specific types of activities or to fund research related to a particular disease. 

 Foundations and endowments typically have long investment horizons, high risk tolerance, and, aside from their planned spending needs, little need for additional liquidity. 

There are three major steps in the portfolio management process: 

Step 1: The planning step begins with an analysis of the investor’s risk tolerance, return objectives, time horizon, tax exposure, liquidity needs, income needs, and any unique circumstances or investor preferences.

Step 2: The execution step involves an analysis of the risk and return characteristics of various asset classes to determine how funds will be allocated to the various asset types.

Step 3: The feedback step is the final step. Over time, investor circumstances will change, risk and return characteristics of asset classes will change, and the actual weights of the assets in the portfolio will change with asset prices

MODULE 38.2: POOLED INVESTMENTS